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A Secret to Lower Taxes: Special Deduction for Self-Employed Health Insurance

Article Highlights:

  • Who Qualifies for the Self-Employed Health Insurance Deduction?
    o   Self-Employed Individuals
    o   Partners in Partnerships
    o   S Corporation Shareholders

  • Where is the Deduction Claimed?

  • The Tax Benefit

  • What Insurance Qualifies

  • Limitations and Restrictions

In the labyrinth of tax regulations, the self-employed health insurance deduction stands out as a beacon of relief for self-employed individuals, partners in partnerships, and shareholders in S corporations. This deduction allows eligible taxpayers to deduct 100% of their health insurance premiums from their gross income, providing a significant tax benefit. This article looks at who qualifies for this deduction, the nature of qualifying insurance, and the process of claiming it.

Who Qualifies for the Self-Employed Health Insurance Deduction?

  • Self-Employed Individuals - Self-employed individuals who report a net profit on Schedule C (Form 1040) or Schedule F (Form 1040) are eligible for the self-employed health insurance deduction. This includes freelancers, independent contractors, and small business owners who are not considered employees of another company. The deduction is limited to the net earnings from self-employment, after accounting for the 50% of self-employment tax deduction and contributions to certain retirement plans (but not traditional IRAs).

  • Partners in Partnerships - Partners with net earnings from self-employment, as reported on Schedule K-1 (Form 1065), box 14, code A, can also take advantage of this deduction. The health insurance policy can be in the name of the partnership or the partner.

    o    If the partnership pays the premiums, the premium amounts must be reported on Schedule K-1, Form 1065, as guaranteed payments included in the partner's gross income.

    o    If a taxpayer/partner pays the premiums, and the policy is in the taxpayer/partner's name, the partnership must reimburse the taxpayer and the premium amounts will be included in gross income as guaranteed payments on Schedule K-1. Otherwise, the insurance plan won't be considered established under the business.

  • S Corporation Shareholders - Shareholders who own more than 2% of an S corporation are eligible if the corporation pays their health insurance premiums, which are then reported as wages on Form W-2. The policy can be in the name of the S corporation or the shareholder. If the shareholder pays the premiums and the policy is in their name, the S corporation must reimburse the shareholder, and the premium amounts must be reported on Form W-2 as wages

    o    If the S corporation pays the premiums, the premium amounts are included on Form W-2 as wages.

    o    If the shareholder pays the premiums, and the policy is in the shareholder's name, the S corporation must reimburse the shareholder and report the premium amounts on the W-2 as wages. Otherwise, the insurance plan won't be considered established under the business.

Where is the Deduction Claimed? - The self-employed health insurance deduction is an above-the-line deduction, meaning it reduces the taxpayer’s gross income directly. This advantageous positioning allows taxpayers to benefit from the deduction regardless of whether they itemize deductions or take the standard deduction. The deduction is figured on IRS Form 7206, Self-Employed Health Insurance Deduction, that is attached to the individual’s Form 1040 return. Form 7206 made its debut as part of 2023 returns. Previously, a worksheet in the IRS instructions to the 1040 was used to compute the deduction.

The Tax Benefit – Besides allowing it to be deducted above the line and avoiding the 7½% of AGI medical limitation as an itemized deduction, the SE health insurance deduction also reduces the taxpayer’s AGI. The AGI is frequently used to reduce other tax benefits for higher income taxpayers. This can result in substantial tax savings, making health insurance more affordable for those who are self-employed or small business owners.

What Insurance Qualifies? - To qualify for the deduction, the insurance plan must be established under the name of business, but for self-employed individuals, this means the policy can be in either the individual’s name or the name of the business. For partners and S corporation shareholders, certain conditions regarding the payment and reporting of premiums must be met, as outlined above.

The deduction covers medical, dental, and long-term care insurance premiums for the taxpayer, their spouse, dependents, and children under 27 years of age, even if they are not dependents. Medicare premiums voluntarily paid to obtain insurance in the individual’s name that is like qualifying private health insurance can be used to figure the deduction. I.  

Limitations and Restrictions - While the self-employed health insurance deduction offers significant tax relief, there are limitations.

  • The deduction cannot exceed the earned income from the business under which the insurance plan is established.

  • The long-term care (LTC) insurance premium part of the deduction is limited based on the age of the person covered by the LTC plan.

  • No deduction is allowed for any month in which the taxpayer was eligible to participate in a health plan “subsidized” by their or their spouse's employer. The term “subsidized” means at least 50% of the cost of the coverage is paid by the employer.

If you have questions related to this often-overlooked tax benefit, please contact this office.

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